Netflix (NFLX 0.19%) recently reported results for the third quarter, and they impressed Wall Street. While revenue of just over $8.5 billion was in line with analyst estimates, diluted earnings per share (EPS) of $3.73 handily beat forecasts.
But shareholders in this streaming-service stock care most about subscriber numbers. And Netflix crushed it in this regard, adding almost 8.8 million net new members during the last three-month period. It's no wonder the stock popped double digits following the news.
Does Netflix's strong momentum make the stock a buy? Let's take a closer look.
Dominating the industry
Netflix mentioned that its ad-based subscription tier experienced 70% sequential growth in Q3. That's no doubt a wonderful sign that consumers are seeing value in this cheaper option.
And as it relates to the ongoing crackdown of password sharing, executives are optimistic that this strategic priority will be additive to the business in the near term. "I would say we anticipate that we will have incremental acquisition, incremental ads for the next several quarters," co-CEO Greg Peters noted on the earnings call. "We've seen that in the last couple of quarters."
Now with more than 247 million customers and trailing-12-month revenue of $33 billion, it's easy to see that Netflix is in a league of its own in the streaming industry. Operating in such a competitive market isn't easy, but this business benefits from its tremendous scale. It can still spend a lot of money on content while at the same time driving toward strong profits.
Looking ahead, management expects 11% revenue growth for Q4, which would represent the fastest quarterly gain since Q4 2021.
Impressive financials
Netflix's scale is showing up in the company's financial picture. Management expects the operating margin to be 20% this year, and between 22% and 23% in 2024, which are massive improvements from just 4% in 2016.
The business is looking to produce $6.5 billion in free cash flow this year. Additionally, $10 billion were added to Netflix's share-buyback capacity. These are signs of a financially sound enterprise.
As if this wasn't enough, Netflix's situation looks even better when compared to its key competitor, Walt Disney. In its direct-to-consumer segment, the House of Mouse reported an operating loss of $2.2 billion through the first three quarters of fiscal 2023.
Netflix management just announced that U.S. customers will have to pay more for the Basic and Premium ad-free plans. Bears might argue that the timing of this decision is poor given the uncertainty surrounding the economic environment.
But I'm sure the leadership team has taken the time to think things through. Plus, Netflix should deserve the benefit of the doubt here as it has consistently raised prices over the past decade, which hasn't impacted its ability to grow revenue and members. Should the current price hike be as successful as previous ones, the company's profitability could improve.
What about the valuation?
Netflix shares have climbed 36% this year, but they still remain a whopping 42% below their peak price from November 2021. And currently, the stock trades at a price-to-earnings (P/E) multiple of about 43. That's significantly cheaper than its trailing-five-year average of 69.
To be fair, some investors still might not be comfortable paying an above-market P/E ratio for Netflix shares. But given the company's dominant industry position and its growth prospects, becoming a shareholder could be a good idea.
According to consensus-analyst estimates, Netflix is projected to increase its diluted EPS by 21% per year between 2022 and 2027. So in 2027, this figure is expected to total $25.82, which means the stock currently trades at 15.5 times that estimated EPS sum. Even if the P/E multiple contracted to 31 in five years, the stock is set to roughly double during that time.
This looks like a favorable setup for long-term investors looking to buy Netflix shares.
